Carl Davis of the Institute for Taxation and Economic Policy discusses the biggest trends in state tax policy this year and the effects of the Build Back Better Act, potentially next year.
This transcript has been edited for length and clarity.
Paul Jones: Hi, Carl. Thanks for being with us.
Carl Davis: Thanks for having me.
Paul Jones: Let’s start with one of the most obvious events. Due to the pandemic, there were many states that were clearly concerned that in light of the lockdown, their revenues were going to suffer. But as it turned out later, many states actually enjoyed very healthy revenue and even surplus revenue. There are also some who have debated whether a tax cut or actually a tax cut.
Can you talk about that trend and what’s behind it? And do you think this will continue into the 2022 season? I’m also curious if you think it makes sense for states to react to these near-term surpluses by making long-term changes to their tax base.
Carl Davis: The state budget has been really remarkable. I mean, it’s not at all difficult to imagine a situation where states were required to drastically cut budgets during other recessions and budget cuts, which actually, in many ways, exacerbated the difficulties that we face. Used to see during the pandemic.
Instead, we saw that the federal government was interfering with a very strong policy response, thinking not only of direct aid to states and territories, but of economic impact payments and increased unemployment benefits. Was being What those people did was increase income, increase sales for sales tax purposes, and you end up with a stronger economy than almost anyone expected because of that.
How states responded to that impact on their budget outlook varied greatly. A lot of states have used the money to strengthen their school systems or their infrastructure or public health programs, which we clearly need right now.
But we are also seeing examples of, as you said, tax cuts by states. Actually sales tax is not that much, we have not seen sales tax cut. In the case of large tax cuts, it has mostly been on the income tax side. With income tax, the question is, who will deduct those taxes? You actually have the ability to fix income tax deductions to pass on to families at any point on the income scale, or to do it more widely.
States have actually taken a very different approach here. In a state like Washington, Maryland, or Connecticut, the priority in their tax cuts was actually for low-income workers and raising their standard of living through a sizable earned income tax credit. Colorado, they did so too, but also funded a child tax credit that extended not only to low-income workers, but also to middle-income families to higher income levels.
Then you also have the saying that, quite frankly, tax deductions are prioritized for their most affluent families. The states that come to mind here would be New Hampshire, Arizona, and Ohio. There are others. Typically those tax cuts are being marketed as a means of economic growth. Think of it as the trickle-down theory of modern times, with tax cuts on top finding their way to everyone else.
I’m particularly concerned about that approach. I don’t know that there is evidence that such tax cuts at the state level are going to have a meaningful, positive impact on state development. I think what we’re going to see in a lot of cases in the long run is that this rosy budget picture isn’t going to last forever. But in many cases, these tax deductions were written to last forever.
You may end up with a situation where shrinking class sizes have fewer resources, expanding healthcare, any number of other services. What you can see instead is more pressure on regressive tax sources. States are turning to things like higher sales tax and higher excise duty to take the long-standing slack due to these tax cuts.
When this happens what we see is a shift towards more regressive state taxation in general. We have “Who Pays?” There is a report called. Which looks at the distribution of taxes by income level, and we find that states are generally taxing in a somewhat regressive manner. I think the income tax cuts that we have seen in some states have the potential to make it worse, especially in the long term.
Paul Jones: Correct. I know there were some states that were discussing abolishing their income tax. I think Mississippi was one, and I believe the governor actually recently revived a proposal to get rid of that state’s income tax. Do you think we will see more states moving in that direction? Do you think those proposals are likely to move forward next year? Or is that bridge too far?
Carl Davis: Yes. You know, for the past decade, I think we’ve seen a state debate or two almost every year. It’s a really difficult thing to put into practice.
For one thing, states have balanced budget requirements, so if you’re going to completely eliminate one of your major sources of revenue, the public services, the public institutions you have to cut to do so. , that is a huge human toll . Broadly speaking, they also create a lot of economic concerns.
What we saw in Mississippi was that the business community was not particularly enthusiastic about the income tax abolition plan. In some instances, when they were looking down the street and saying, “Well, what does this mean for our infrastructure? And what does this mean for our higher education system and our ability to attract There seems to be an outright hostility to the copy. Highly skilled staff?”
The only state that actually managed to repeal the comprehensive income tax was Alaska. They did this only when it became clear that they were sitting on huge amounts of oil that could be used to fund their budget. A very different situation than Mississippi, or say, West Virginia finds itself in right now.
In Mississippi, the governor’s current proposal, as I understand it, would not even offer any replacement revenue. Sometimes an income tax abolition scheme can be combined with a higher sales tax.
For many families, they may not even experience it in the form of a tax deduction. In general, if you have a lot of income, you’ll probably get a sizable income tax deduction. If you have a more moderate income, your higher sales tax bill can easily offset whatever income tax deduction you may get. It ends up being more of a tax change than a tax cut.
Well, in Mississippi, what they’re talking about now is not replacing revenue, not raising sales tax, not doing anything like that. I think to make that work, you’d have to see really amazing budget cuts that would be extremely difficult to navigate through the legislature.
One way they might try to deal with it is with a very slow phase of income tax repeal, maybe triggering, maybe not. What the legislature would allow to do is actually postpone all difficult decisions until later. Perhaps much later, when the current crop of lawmakers are no longer even in office. I see that kind of approach, these long steps, really as a gimmick because it equates to lawmakers bypassing the central question in every tax and budget debate, which is around priority.
If you do more than that, what are you going to do less? In this case, there’s going to be more income tax deductions and less we don’t know, because we’re going to put that decision off for years or even decades. So, I think in order to make the math work, we can see them moving in the same direction.
I do not consider this a prudent policy course. Its fare may depend on how the business community reacts to that kind of plan. But maybe things are moving forward. In general, I think we’re going into another year where many states talk about tax cuts.
Now it remains to be seen who will benefit from the tax cut? How will they be designed and where will these tax deductions be targeted, especially at different points of income?
Paul Jones: It seems, as you mentioned in your earlier answer, that there are some states that are specifically cutting taxes on low-income earners. This can be seen as a progressive reform unlike the other approach where you have states cutting taxes especially towards reducing the tax burden on high income earners.
We should note that there were some states that actually went in the opposite direction and were trying to make their tax codes more progressive. States like Washington, which instituted a new capital gains tax, New York, Colorado, and I believe the District of Columbia have as well.
Given this, what are some policy considerations that states should consider as they move in that direction? Do you think there are going to be some states that are insisting on improving the progress of their state tax regimes?
Carl Davis: I think this will continue to be a major topic of debate. Over the past several years, awareness of issues of inequality has increased significantly. Inequality in both income and wealth.
There is a huge difference between us in both of those measures. Especially economic inequality and racial inequality…